Background
Joel Greenblatt is the founder of Gotham Capital and the creator of the 'Magic Formula' investing strategy. Gotham Capital returned 50% annually for 10 years. His Magic Formula ranks stocks by two criteria — earnings yield and return on capital — and buys the highest-ranked companies. His backtesting showed this simple formula beat the market by a wide margin over 17 years.
Core Methodology
The Magic Formula sorts all stocks by two factors: earnings yield (EBIT / Enterprise Value) and return on capital (EBIT / Net Working Capital + Net Fixed Assets). Each stock gets a rank on both factors, and the combined ranking identifies 'good companies at cheap prices.' The strategy buys the top 30-50 ranked stocks, holds for one year, and rebalances.
Key Trading Rules
- Rank all stocks by earnings yield (EBIT / Enterprise Value) — higher is better (cheaper)
- Rank all stocks by return on capital (EBIT / [NWC + NFA]) — higher is better (more efficient)
- Combine both rankings — buy the top 30-50 stocks with the best combined rank
- Hold each position for at least one year (tax efficiency: hold losers 366 days, winners 364 days)
- Rebalance annually — sell the old portfolio and buy the new top-ranked stocks
- Expect 3-5 year periods where the formula underperforms — stick with it through drawdowns
Key Concepts
Books & Resources
The Little Book That Beats the Market by Joel Greenblatt. You Can Be a Stock Market Genius by Joel Greenblatt. MagicFormulaInvesting.com (free screening tool).